Stock Market On a Glide Path Towards Dow 11,000

By: Paul_J_Nolte

All the market and the economy are asking for is a little bit of respect. The expectation of better economic news, coupled with above estimated earnings has put the equity market on a glide path towards 11,000 over the course of the next few months. The economy is on a bumpy recover, with manufacturing replacing all the stuff bought over the past six months (inventory rebuild), while productivity of American workers is through the roof. So goes the bullish argument.  However, the king of lagging indicators, unemployment is not really showing signs of “expansion”.

Since the peak in employment, the current recession has lost a greater percentage of workers (more than 5%) than anytime since WWII. After nearly 2 years of job losses, it is rapidly approaching the ’01-’04 period for length before job creation sets in. While it may be lagging, the breadth and depth may keep consumers on the sidelines through the huge Christmas selling season, making those workers do more with less.
 
One reason for the lack of respect is the lack of conviction in the financial markets. Last week the markets rose more than it fell in the prior week, however the market “internals” did not reverse last week’s poor showing. For example, gaining stocks were 2300 this week vs. just over 2800 losing stocks last week on the NYSE. Volume, the sign of investor interest, fell every day (save for the 200 point gain – then it expanded by 2%) last week and Friday’s employment report market gain saw the slowest day in a month. While the bullish camp is touting good earnings and momentum, our concern is lack of participation and persistently bullish sentiment.

Investor’s Intelligence is reporting 48% of advisors as bullish, among the highest all year. While still below the peak of 55 early in ’07, it is certainly a long way up from the nadir reading of 22 a year ago. Based upon as reported earnings, the SP500 is selling at over 17x earnings at the end of 2011. Seventeen is as about as cheap as we have seen over the past 20 years, but is well up from the 11-12x earnings of the late 1980s, when earnings were growing no faster than today. At 13x projected 2011 earnings, the SP500 should be at roughly 800.
 
Even though the Fed indicated they will be keeping interest rates at the 0-0.25% until they see signs of economic growth (read: employment improving), out interest rate model spent the second week in “sell” territory, indicating that the most likely direction of rates is higher. The 30-year bond has moved from 4% to 4.4% over the past five weeks, while commodity prices have jump 8% and gold prices increased by over 10.5%.

Coming up this week will be another large bond auction, although they have been well received in the past, may have trouble this go-round as foreign investors have been getting hurt by the weaker dollar. Due to the Fed policy of keeping rates low, short-term bonds are providing very little in the way of return, however they are much more likely to hold value if rates indeed begin to rise.

By Paul J. Nolte CFA
http://www.hinsdaleassociates.com
mailto:pnolte@hinsdaleassociates.com

Copyright © 2009 Paul J. Nolte - All Rights Reserved.
Paul J Nolte is Director of Investments at Hinsdale Associates of Hinsdale. His qualifications include : Chartered Financial Analyst (CFA) , and a Member Investment Analyst Society of Chicago.

Disclaimer - The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.

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